Question

A typical Australian farmer can produce 8000 lbs of wheat or 500 lbs of potatoes per year. A typical Canadian farmer can produce 5000 lbs of wheat or 400 lbs of potatoes per year. For the exchange rate of 1 lb of potato = 11.00 lbs of wheat, please indicate if Canada and Australia will ACCEPT or REJECT the trade:

Australia:Accept / Canada:Reject

Australia:Reject / Canada:Accept

Australia:Accept / Canada:Accept

Australia:Reject / Canada:Reject

explain clearly！！

Answer 1

	Wheat (lbs)	Potatoes (lbs)
Australian farmer	8000	500
Canadian farmer	5000	400

For Australia : Opportunity cost for producing potatoes = 8000/400= 16 lbs wheat

For Canada : Opportunity cost for producing potatoes = 5000/400= 12.5 lbs wheat.

Because Canada has the lower opportunity cost in the production of potatoes. So, it has the comparative advantage in producing potatoes. Therefore, it will export potatoes and Australia will export wheat.

If the exchange rate lie between 12.5 and 16 lbs per potato , then only it will be beneficial for both country.

And here , the exchange rate is 1 potato for 11 lbs of wheat.

Australia would benefit from trade with the given exchange rate because they will export less amount of wheat now for each potato it imported.

Canada will not benefit from trade because they will get less amount of wheat for each lbs of potato it exported.

Therefore, Australia : Accept and Canada : Reject the trade. Hence, option(A) is correct.

To make them both benefit , the exchange rate should lie between the two countries opportunity cost.